Mises made at least three significant contributions to economics. The first contribution is in money and business cycle theory. What Mises tried to show is how money is central to all exchanges, because in a monetary economy, goods trade for money and money trades for goods. Goods don’t trade directly with other goods. Since money is one-half of all exchanges, if you screw around with money, you’re going to screw around with all the exchanges in the economy. He postulated that when the government distorts the monetary unit, through the manipulation of money and credit, it can generate boom-and-bust cycles. So rather than the business cycle being inherent to capitalism, it’s a consequence of distortions caused by the manipulation of money and credit.

TWO: PERFECT ECONOMIC PLANNING IS IMPOSSIBLE, WHAT MORE WITHOUT MARKET PRICES AS KEY INFORMATION

His second contribution was on the controversy over socialism, and whether it could engage in economic calculation. To put it simply, economic calculation helps you sort out – from the array of technologically feasible projects – those which are economic and those that aren’t. For example, you don’t want to build railroad tracks out of platinum, you want to build them out of steel. Platinum might well be technologically superior – smoother, longer-lasting – but it costs too much. The idea of socialism was to completely transcend the market economy, but if I don’t have prices and I don’t have exchange ratios established on the market because I have abolished commodity production, how am I going to know that I have to use steel?

Mises came in and said: Let’s assume that ends of socialism are highly desired – I’m not going to engage in a battle over ends. What is it socialists want to achieve? A burst of productivity, leading to an overcoming of the conflict between classes. What is their means to attain that goal? Collective ownership over the means of production. Rationalisation of production for direct use and not for exchange will produce this burst of productivity that will overcome scarcity and therefore the conflict between the classes. What Mises said was: Your means are in conflict with your ends, because you can’t engage in economic calculation. You’re not going to get rationalisation of production, you’re going to have endemic waste. He was the first person to demonstrate that. As the history of the Soviet system played out, including its early history from 1917-21, it seemed to play out Mises’s argument. Socialists were always making compromises with respect to their original plan, trying to jerry-rig it, and you get on this treadmill of economic reforms that characterise the entire Soviet period. Then, eventually, it unwinds in the late 1980s, and you even have people like [left-wing economist] Robert Heilbroner admitting that Mises was right.

THREE: ECONOMCIS IS A WONKY SCIENCE BASED ON WONKY HUMAN BEHAVIOUR

Mises’s third contribution is an argument about methodology in the social sciences. He argues that human sciences are different from the natural sciences. His methodological argument cut against the trend of the times, which was to move towards a unity of science approach – what’s right for physics is right across the board. Mises talks about methodological dualism. To communicate this simply, he used to say: “If you throw a rock into water it sinks; if you throw a stick into water it floats; if you throw a man into water he must decide whether to sink or swim.” What does that mean then for the way we approach the social sciences? If you think about economists, in the 18th and19th centuries – John Stuart Mill, David Hume, Adam Smith – they were philosophers. The way they reasoned was like a philosopher. When you get to the mid-20th century and you look at Paul Samuelson, he’s not a philosopher any more, he’s more like an engineer. His books look like engineering or chemistry books. There was a transformation of economics – it became a tool of social control.

To the Austrians, economics is not a tool of social control, it’s a framework for helping us understand humanity, its history, and our plight in the world. Hayek had a great phrase about this. He said that the curious task of economics is “to demonstrate to men how little they really know about what they imagine they can design”. Hayek’s Nobel Prize address was called “The Pretence of Knowledge”. He was going after the idea not only of socialism, but of large-scale macro models. Because in the mid-20th century, and going up through the 1970s, the economy was envisaged like a bathtub. One spigot was monetary policy and the other was fiscal policy, and an economist’s task was to turn those spigots on to make sure the water rose to the level in the bathtub that was consistent with full employment.

Mises and Hayek stood in complete opposition to that view. Even more so than Milton Friedman, because he’s arguing over which is more effective – fiscal or the monetary policy, but he’s still telling us we’re in control of the levers. What Mises and Hayek are saying is that that whole way of thinking about the economy reflects a pretence of knowledge – that we know what the full employment output level would be, that we know exactly how much water to let in, and how much to let out – whereas in reality, if we make a mistake with any of that, the water comes gushing out all over our bathroom floor, or it drains completely out and we have nothing.

The belief that social sciences should be like social physics is built on an assumption which Mises says you can’t make. Therefore you mischaracterise what the task of economics is – you send economics in a direction which is totally different from our heritage, of what we got from David Hume, Adam Smith, Jean-Baptiste Say and John Stuart Mill, and then Carl Menger, and then Mises, Hayek, and other people in the 20th century, like Jim Buchanan.